NKE: Pre-Print Thoughts

Here’s our view on NKE into the quarter. While we have them coming in above consensus, it matters little to our positive longer-term TREND call on the name. Here’s a small excerpt from our Nike Black Book showing our TRADE duration:

TRADE: We like Nike's earnings into the quarter -- though in today's tape, we're not quite sure if that matters. We’re modeling $1.30 vs. the Street at $1.21. We’re somewhat aggressive on the gross margin line with a decline of -250bps relative to guidance of -300bps (and the Street at -290bps) as we think that Nike’s inventory is particularly clean at retail, and pricing strategies have gotten off to a good start at retail. Also, we have Demand Creation down 8% vs. last year as Nike anniversaries the remnants of World Cup, and saves its Demand Creation dollars for the back half of the year. We’re likely looking at another quarter of heavy inventory investment – as seen over the past two quarters. But then starting in the November quarter, we start to see increasingly easy comps on the balance sheet (and subsequently the margin line on the P&L).

Our call on Nike goes far beyond the quarter…

We think that investors are underestimating both the depth and duration that Nike’s recent infrastructure investments will have on financial results. It is one of the few companies that fits within our three different durations – TRADE (3 weeks or less), TREND (3 months or more) and TAIL (3 years or less). We like it at current levels, and think that there is upside to earnings in the coming quarter, the remainder of the May 12 year, and throughout the next three years. If Nike puts a lid on guidance on Thursday, as its biorhythm so often leads it to do with 1Q earnings, then we think it will be a great shot to get involved.

True, with a current EBITDA multiple of 10x our F12 estimates, Nike might not look like the cheapest name out there. But we think that earnings and cash flow expectations are too low across all durations, and that Nike has such a commanding lead right now in a global duopoly backed by the tools to sustain it. Combine that with a bullet proof balance sheet and what we think is a permanent structural advantage in sourcing product in a strengthening Yuan climate and this story has some serious legs to stand on.

We issued our first Nike Black Book on March 1stof last year, as we thought that the multi-year restructuring at Nike would start a reacceleration in sales, earnings, and returns. We think that played out pretty well over the ensuing year. While the stock has continued to outperform on the margin, there’s definitely been more concern creeping back into the consensus as to the sustainability of business trends, reliance on a so-called ‘sneaker cycle,’ and the direction of earnings growth in a global economic climate that most would agree is treacherous at best.

Why? People tend to focus on ‘comping the comp’ with futures – as they do most retail growth metrics. For your average company – one that gets lucky on a trend, a specific business initiative, or the economy – that’s a fair thing to keep in mind.

While we can’t completely ignore that with Nike, we need to respect its proactive approach to creating its own destiny, and it’s proven track record of a) investing capital in new business initiatives and taking share, b) realizing when it’s time to change its organization in order to adapt to a changing marketplace, and c) making the right changes to facilitate its next leg of growth – even if unpopular with shorter-term investors.

While its investments have been well telegraphed, the results have not. Yes, we’ve seen an acceleration in futures trends, but the depth, breadth and duration of the company’s product and distribution pipe is still far from understood (by Wall Street and competitors alike).

The company was in what we’ll call ‘restructuring mode’ for the better part of two years. If you look at Nike historically, you’ll see that its payback vs. restructuring was 2-3x as measured by time. Similarly, cash on cash returns on incremental capital averaged better than 20%.

There’s no reason why this won’t hold true this time around, and in fact should generate return on assets starting with a 3. which suggests to us that Nike will, in fact, add another $7-$8Bn in revenue over the next 3-4 years.

This is not just blind faith on our part. We’re already seeing it in several areas – including three critical areas we outlined in our last Black Book that needed to be addressed, a) Apparel, b) Retail, and c) Women. This represents a critical power base inside the company that is just starting what we think will be a continued key driver to Nike’s business over time.

For more information on our Nike Black Book, please contact , or call to request access.

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09/22/11 10:50 AM EDT

WMT: TREND line break. Selling.

Keith sold WMT in the Hedgeye Virtual Portfolio managing Macro market risk with the intermediate-term TREND line of support broken shortly after the open.

As it relates to the stock, if you believe, like we do, that the ‘trade down’ theme for the consumer is still very much alive and likely to accelerate, then WMT is one of the best places to look within retail.

In 1993, the Maastricht Treaty established the European Union and the path towards a monetary union and common currency in Europe.

On this path, the euro was launched in 1999 and has been a particular catalyst for criticism. Most notably, Nobel Laureate Milton Friedman stated in 1999 that he did not believe the euro would last ten years.

In contrast to Friedman's prognostication, the euro has lasted more than ten years, but just barely. In fact, many global markets are currently implying that Europe's monetary union and common currency are on the precipice of collapse.

Today Thursday, September 22nd, 2011, Hedgeye will be hosting a conference call to discuss the future of the Eurozone and the implications for global markets. The call will focus specifically on three topics:

Review of the history and structure of the Eurozone

Assessment of the current situation and imminent risks and opportunities

Analysis of potential and realistic scenarios to solve the crisis in Europe

Please contact if you have any questions.

Regards,

The Macro Team

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the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

THE HBM: SBUX, CHUX, DNKN, DRI, KKD, YUM and DPZ

Jobless claims are uncomfortably close to their recent highs - weakness in the labor market continues. I continue to believe that consumer demand over the past nine months wasn’t strong enough to overcome another bump in unemployment.

KKD - September 29 Krispy Kreme will celebrate National Coffee Day and its new Krispy Kreme Signature Coffee Blends by giving a FREE 12oz cup of House Blend Coffee to its guests. No Purchase Necessary.

YUM - Niren Chaudhary, managing director of Yum! Restaurants India Pvt. Ltd., said the company is aiming at total sales of $1 billion from India by 2015 and it will invest $150 million to take the number of its restaurants in India to 1,000 by 2015, from 400 currently.

SBUX - Robert Luciano, director of store development for Starbucks Coffee Canada is talking about significant growth opportunities in Canada.

SBUX - Bloomberg is also reporting that “Starbucks Corp. plans to double or triple the company’s outlets in Germany from 150 in the next several years, Handelsblatt reported, citing an interview with Chief Executive Officer Howard Schultz.”

DPZ - The new pizzas from DPZ look to be hitting home with consumers priced at $7.99

DRI and Publix will work with the nonprofit Sustainable Fisheries Partnership to help rebuild fish populations. Darden unveiled the plans Wednesday at the Clinton Global Initiative's seventh annual meeting and said its first goal is to focus on rebuilding commercial grouper and red snapper reef fisheries in the Gulf of Mexico.

Howard Penney

Managing Director

Rory Green

Analyst

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09/22/11 09:03 AM EDT

15 Things That Caught Our Eyes This Morning

We have not seen a 24 hour turn in global macro market prices like this since 2008. No, this is not 2008. This is 2011, but globally interconnected market risk remains very real.

DAX fails at TRADE line resistance of 5489, and has no support to prior closing lows

CAC/IBEX/MIB indices look no different than the DAX – all in Crash Mode

Russia down -5.4% and crashing (down -31% since April!)

Hong Kong blasted for a -4.9% move and its now in crash move alongside the KOSPI

Indonesia (one of the world’s best economies in 2011) down -8.9% on no news!

CRB Commodities Index has broken its TAIL line of 333 and confirmed what Dr Copper and Oil prices see

Copper down -5% in a straight line and it moves into crash mode for 2011 now too (down -21% since FEB)

Oil confirms yesterdays TRADE line break; what was support is now resistance at $86.91

Gold is now a source of funds; that’s $1821 TRADE line break that got me out, puts $1630 in play on the downside

10-year US Treasury yields blew through the stop sign making lower-lows at 1.80%; that’s just bad for a lot of reasons

Bernanke couldn’t have fundamentally understood that a 1-day 21bps compression move (11%) in the Yield Spread would do this to both the Financials (net interest margins, cash earnings, stock prices, etc), the bond market, and Global Macro risk. He’ll start to get it now.

This is a serious risk day for serious people. We are not being alarmist. We weren’t in Q3 of 2008 either.

Initial claims fell 5k WoW last week (9k net of the revision to the prior week). This brings the level to 423k. On a 4-week rolling basis, claims are up 1k WoW to 421k. As a reminder, in looking at the spread between the S&P and 4-wk claims, the current S&P level would equate to a rolling claims level of 460k.

Our general take here remains that the market and economy are reflexive, as George Soros would say. In other words, markets don't predict recessions, they cause them. The volatility over the past few months, and continuing this morning, is creating a profound loss of confidence among consumers and employers. We have been surprised to date by the resiliency of the claims figures in the face of this. We would be equally surprised if it persists. To reiterate, based on our simple mean reversion framework highlighted above, we would expect to see claims rise to ~460k mean reverting to where the market is.

In the fourth chart below we show the relationship between the Fed's Treasury and Agency holdings and initial claims. The two series appear to be related. Both series also show a relationship with the S&P. The direction of causality isn't certain here. Our understanding is that Fed purchases boost risk assets, particularly equities, and an increase in equity levels drives claims lower. According to that scheme, if Operation Twist fails to boost risk assets, we would not expect a positive reaction in initial claims.

2-10 Spread Not Letting Up

Acute margin pressure remains in force, looking at the 10-year yield and the 2-10 spread. The 10-year yield is now 133 bps lower than it was at the end of 2Q.

Subsector Performance

The chart below shows the performance of financial stocks by subsector.

Joshua Steiner, CFA

Allison Kaptur

Having trouble viewing the charts in this email? Please click the link below to view in your browser.

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